Bond Market Development in Emerging East Asia Types of Bonds, Credit Ratings, Functioning of a Bond Market Angelica Andrea Cruz AsianBondsOnline Consultant
Types of Bonds Credit Ratings Functioning of a Bond Market
Central Government Bonds Bonds issued by a country s national government to finance fiscal deficits and for the repayment or refinancing of the government s outstanding obligations. Treasury Bills Issued at a discount to par value, no coupon rate, mature at par value, and have maturities of less than 12 months. Issue Date Par Value = USD1,000 Issue Price = USD700 Maturity Date Principal Repayment = USD1,000
Central Government Bonds Treasury Bonds/Notes Issued at par value, pay coupon interest, and mature at par value, and have original maturities of more than one year. Issue Date Par Value = USD1,000 Issue Price = USD1,000 Coupon Rate = 5% per annum Frequency : semi-annual Coupon Payment Dates Coupon Payment = USD50 per annum; or USD25 per coupon payment date Maturity Date Par Value = USD1,000 Issue Price = USD1,000
Retail Treasury Bonds Retail Treasury Bonds Treasury securities that primarily cater to retail investors with lower minimum investment Part of the national government s program to allow treasury securities to be available to the general public Coupon payment is paid quarterly Source: Bureau of the Treasury
Treasury Inflation-Protected Securities Treasury Inflation Protected Securities Treasury securities that adjust for inflation. On each coupon payment date, the principal used for the computation of coupon payment is adjusted for inflation. Treasury Nominal Yield = Real yield + Expected Inflation Rate + Inflation Risk Premium = 3% + 3.5% + 0.5% TIPS = Real Yield + Lagged Actual Inflation Rate = 3.5% Par Value = USD1,000 Coupon Rate = 3.5% p.a. Lagged Semi-Annual Inflation Rate = 1.5% 1 st coupon payment day (6 months): Adjusted Principal = Par Value x (1 + semi-annual inflation rate) = USD1,000 x (1 + 1.5%) = USD1,015 Adjusted Coupon = USD1,015 x (3.5%/2) = USD17.76 or a USD0.2625 adjustment
Central Government Bonds Issuance Central government bonds are sold in the primary market through bond auctions, and are sold and traded in the secondary market through an exchange or via over-thecounter. Risks Normally considered free of credit risk since they are backed by the full faith and credit of the national government
Central Government Bonds Benchmark Issues Most recently issued Treasury securities with comparable maturities. Yields of benchmark issues are used as a base interest rate for the pricing of non-government securities. Data as of 19 July 2016. Source: Philippine Dealing and Exchange Corp.
Central Government Bonds On-the-run vs Off-the-run On-the-run are the most recently issued and most liquid of any given maturity. In general, on-the-run have lower yields (higher price) than offthe-run: High demand vs limited supply of securities Short-term trading of newly auctioned securities
Central Government Bonds Treasury Securities Inflation-Linked Retail Bonds PRC Hong Kong, China / Only a small portion of total bonds. Indonesia Rep. of Korea Japan Malaysia Philippines Singapore / Only a small portion of total bonds. Thailand Viet Nam
Central Bank Bonds The issuance of central bank bonds is one of the tools of monetary policy used by central banks/monetary authorities primarily to manage excess liquidity in the market. Market People s Republic of China Hong Kong, China Indonesia Japan Republic of Korea Central Bank Bonds / But only a negligible share to total bonds as the PBOC has been using other tools to manage liquidity. Exchange Fund Bills (EFBs) - tenors of 91-, 182-, and 364-days Exchange Fund Notes (EFNs) effective January 2015, HKMA ceased new issuance of EFNs with tenors of 3 years and above; issuance of 2-year EFNs continues. Sertifikat Bank Indonesia (SBI) 9-months, 1-year Bank Indonesia also issues foreign-currency denominated SBIs. Monetary Stabilization Bonds (MSB) - discount and coupon instruments with various tenors ranging from 14 days to 2 years Malaysia Bank Negara Malaysia Monetary Notes (BNMN) tenors of 91-, 182-, 364-days and 1- to 3- years. Sukuk BNM Issues (SBNMI) tenors of 1- to 2- years Philippines Singapore Thailand Viet Nam Monetary Authority of Singapore (MAS) bills tenors of 4-, 12-, and 24-week Bank of Thailand issues bills and bonds; Discount Bonds <15-days, 3-months, 6-months, and 1-year; Bonds 2- and 3- years State Bank of Viet Nam (SBV) bills tenors of 28-, 90-, 91-, 366-, and 385- bills
Municipal Bonds Purpose Reduce the reliance of local government units on national government for the funding of their development projects Proceeds from short-term municipal bonds are used to cover seasonal and temporary fund shortages Proceeds from long-term municipal bonds are used for financing of infrastructure projects. Types Tax backed Debt are issued by local governments and are secured by some form of tax revenue. Revenue bonds are used to finance a certain project (infrastructure), and servicing of debt will be sourced from revenues of the project.
Municipal Bonds Risks Changes in economic and social trends that may affect the source of tax revenues Revenue bonds are non-recourse Municipal Bonds in ASEAN+3 Among the ASEAN+3 markets ex-japan, only the People s Republic of China, Republic of Korea, Philippines, and Viet Nam have municipal bonds.
State-owned Enterprise (SOE) Bonds Bonds issued by government-owned entities. These bonds may either have a direct, implied, or no government guarantee. Select SOE Bond Issuers PRC Hong Kong, China Indonesia Rep. of Korea Malaysia Philippines Singapore Thailand Viet Nam China Development Bank, Agricultural Development Bank of China, Export-Import Bank of China Hong Kong Mortgage Corp., Hong Kong Airport Authority, Mass Transit Railway Corp. Perusahaan Listrik Negara, Indonesia Eximbank, Bank Tabungan Negara Korea Development Bank, National Housing, Seoul Metro Cagamas Berhad, Khazanah Nasional Berhad, Syarikat Prasarana Negara Berhad National Food Authority, Power Sector Assets and Liabilities Management Corporation, National Power Corporation Housing and Development Board, Public Utilities Board Bank for Agriculture and Agricultural Cooperatives, Government Housing Bank, Export-Import Bank of Thailand Vietnam Development Bank, Vietnam Bank for Social Policies, Vietnam National Coal, Bank for Investment & Development of Vietnam
Corporate Debt Securities Types Corporate Bonds o Issued to the public through investment banks that fully underwrite the amount to be raised. Medium-term Notes o Securities offered continuously to investors by an agent of the issuer, with maturities ranging from 9 months to up to 30 years. Commercial Papers o Short-term unsecured promissory notes used to meet shortterm obligations of the issuer, with maturities to up to 270 days. o Issued as part of a continuous rolling program or roll-over Bank Obligations o Negotiable Certificate of Deposits o Tier 2 Notes
Oustanding LCY Bonds Outstanding LCY Bonds in Emerging East Asia USD billion USD billion 7,000 350 6,000 5,000 Corporate Government - Others Central Bank Central Government 300 250 Corporate Government - Others Central Bank Central Government 4,000 200 3,000 150 2,000 100 1,000 50 0 China, People's Rep. of Korea, Rep. of Others 0 Malaysia Thailand Singapore Hong Kong, China Indonesia Philippines Viet Nam Note: Data as of end-march 2016. Source: AsianBondsOnline.
Asset-backed Securities Asset-backed securities (ABS) are securities backed by a pool of mortgages, loans or receivables. Rationale Allows capital constrained corporations and financial institutions to raise funds Lowers risk by separating the assets from the credit profile of the originator, allowing the SPV to issue bonds with a better credit profile Types of ABS 1)Mortgage 2)Credit Card Receivables 3)Auto Loan 4)SME Loan
Securitization What is Securitization? Process of structuring an illiquid asset into a new security that can be traded and sold to the market. SPONSOR Sale of Receivables/ Asset Cash from ABS issuance TRUSTEE Transfer of Receivables SPV Cashflow from receivables for the payment of interest and principal Issue ABS INVESTORS Cash from ABS issuance
Asset Securitization Market in ASEAN+3 Outstanding Size of Asset Securitization Market in ASEAN+3 & Selected Comparator Countries (in USD million) China, People's Rep. of 2,831 Japan 175,719 Korea, Rep. of 133,376 ASEAN-4 6,301 of which: Indonesia 216 Malaysia 4,102 Philippines 1,348 Thailand 636 Source: ASEAN+3 Research Group 2013-2014
Infrastructure Bonds Backed by cashflows to be generated from an infrastructure project Debt securities issued by both government and private entities for the primary purpose of financing infrastructure projects Typically issued via a special purpose vehicle and through a project financing transaction. Infrastructure bonds can have tax incentives, credit enhancements, and guarantees.
Infrastructure Bonds Infrastructure Assets are considered to generate stable cashflows due to the following characteristics: Monopoly structure Low demand elasticity since most are public goods Infrastructure Bonds also have low correlation to other asset classes. Risks Political and sovereign risk including changes in tax laws, utility prices Reneging of government from the project
Catastrophe Bonds High-yield securities issued by insurance and reinsurance companies via an SPV to transfer risks and losses in the event of a catastrophe Inherently risky and have maturities of 5 years or less Periodic interest payments Principal is foregone when a pre-defined trigger event occurs
Catastrophe Bonds Cash from Issuance of CAT bonds Insurance Premiums INVESTORS CAT Bonds SPV Reinsurance Agreement SPONSOR Principal and Interest Payments Returns from Investments Reinsurance Coverage SPV Invests in High Yield Instruments High Yield Instruments
Catastrophe Bonds Trigger Mechanisms Indemnity bond is triggered by actual losses Modeled Loss bond is trigged based on losses generated by using actual parameters of catastrophe in the model Industry Loss Index bond is triggered by actual industry loss Parametric bond is triggered by actual parameters of catastrophe
Islamic Bonds or Sukuk Investment certificates representing a claim on an existing or well-defined asset, deemed to be compliant with Islamic financing principles and religious principles of shari ah. Different from conventional bonds which represent claims on cash flows. Some Forbidden Activities Unjust enrichment (riba) or the payment of interest Gambling or speculation (masir) Corruption (rishwah)
Islamic Bonds/ Sukuk Outstanding Sukuk in Emerging East Asia Notes: 1. Emerging East Asia s sukuk market comprises Brunei Darussalam; Hong Kong, China; Indonesia; Malaysia; and Singapore. 2. Data includes local currency and foreign currency sukuk. 3. Local currency and foreign currency values were converted based on 30 June 2015 currency exchange rates and do not include currency effects. Sources: Autoriti Monetari Brunei Darussalam, Bank Indonesia, Bank Negara Malaysia Fully Automated System for Issuing/Tendering (FAST), Directorate General of Budget Financing and Risk Management Ministry of Finance, Otoritas Jasa Keuangan, and Bloomberg LP.
Islamic Bonds/ Sukuk Breakdown of Sukuk Outstanding per Market Note: Data as of end-june 2015 Source: AsianBondsOnline.
Credit Ratings Functioning of a Bond Market
Credit Ratings A credit rating agency s assessment of the creditworthiness of a bond issuer (Issuer Rating) or the assessment of default risk of a certain bond issuance (Issue Rating) at a certain point in time. The credit rating is also continuously reviewed and revised (if applicable) depending on changes in factors that may affect the risk profile of the issuer/issuance. Bonds are generally classified as either Investment Grade or Below Investment Grade. Global Credit Rating Agencies: Moody s Investors Service, S&P Global Ratings, and Fitch Ratings
Credit Ratings Foreign Currency/Local Currency Ratings Credit rating agencies also assign different ratings on a bond issuer s local currency and foreign currency obligations Credit Ratings and Bond Pricing Credit ratings also provide a basis for the pricing of a certain bond issuance. High credit rating would mean a lower risk of default thus offering lower yield Low credit rating would mean a higher risk of default. Lowerrated bonds generally have higher yields.
Determinants of Credit Ratings Sovereign Bonds Per capita income GDP growth Inflation Fiscal balance External balance External debt Economic development Default history Corporate Bonds Financial statement analysis (liquidity, solvency, etc.) Management Industry analysis Regulatory environment Parent company support agreements Special event risk Collateral Covenants
Credit Ratings Long-term Issue Ratings Highest Grade/ Best Quality INVESTMENT GRADE Moody s S&P Global Ratings Fitch Aaa AAA AAA High Grade/High Quality Aa1, Aa2, Aa3 AA+, AA, AA- AA+, AA, AA- Upper Medium Grade A1, A2, A3 A+, A, A- A+, A, A- Medium Grade Baa1, Baa2, Baa3 BBB+, BBB, BBB- BBB+, BBB, BBB- Speculative Grade Highly Speculative Grade Ba1, Ba2, Ba3 B1, B2, B3 Source: Moody s Investors Service, S&P Global Ratings, Fitch Ratings BELOW INVESTMENT GRADE Moody s S&P Global Ratings Fitch Caa1, Caa2, Caa3 Ca BB+, BB, BB- B+, B, B- CCC+, CCC, CCC- CC C Default C D D BB+, BB, BB- B+, B, B- CCC CC CC
Credit Ratings Rating Watch/Outlook MOODY S STANDARD & POOR S FITCH RATING DESCRIPTION POS Positive Positive Review for possible rating upgrade NEG Negative Negative Review for possible rating downgrade STA Stable Stable DEV Developing Evolving
Credit Ratings LOCAL CREDIT RATING AGENCIES People s Republic of China Indonesia Republic of Korea Japan Malaysia Philippines Singapore Thailand Da Gong Global Credit Rating Co., Ltd Shanghai Far East Credit Rating Co., Ltd PEFINDO Credit Rating Indonesia PT ICRA Indonesia Korea Investors Service, Inc. Korea Ratings Corporation National Information and Credit Evaluation, Inc. Japan Credit Rating Agency, Ltd. Malaysian Rating Corporation Berhad Rating Agency Malaysia Berhad Philippine Rating Services Corporation Credit Rating and Investors Services Philippines Inc. DP Information Group Thai Ratings & Information Services Co. Ltd.
Credit Ratings Fitch S&P Moody's People's Rep. of China A+, stable AA-, negative Aa3, negative Hong Kong, China AA+, stable AAA, negative Aa1, negative Indonesia BBB-, stable BB+, positive Baa3, stable Japan A, stable A+, stable A1, stable Rep. of Korea Aa-, stable AA-, stable Aa2, stable Malaysia A-, stable A-, stable A3, stable Philippines BBB-, positive BBB, stable Baa2, stable Singapore AAA, stable AAA, stable Aaa, stable Thailand BBB+, stable BBB+, stable Baa1, stable Viet Nam BB-, stable BB-, stable B1, stable Data as of 15 July 2016
Functioning of a Bond Market
Market Participants in Primary Market Issuers Institutions that want to raise funds from the market via debt financing. This can include governments, municipalities, corporations, etc. Investors Individuals and/or institutions that provide the funds to the bond issuers. Intermediaries These are market players that link issuers and investors. Involved in the selling of bonds in the primary market and in the trading of bonds in the secondary market. These include banks, investment banks, traders, custodians, trustees, etc.
Bond Issuances in Primary Market Government Bonds via Auction Offer Size: USD20 billion Regular Auction/Multiple Price Method BID AWARD Yield Amount Yield Amount Bank A 3.8115% 10 3.8115% 10 Bank B 3.8215% 5 3.8215% 5 Bank C 3.8315% 15 3.8315% 5 Bank D 3.8415% 12 0
Bond Issuances in Primary Market Government Bonds via Auction Offer Size: PHP20 billion Regular Auction/Single Price Method BID AWARD Yield Amount Yield Amount Bank A 3.8115% 10 3.8315% 10 Bank B 3.8215% 5 3.8315% 5 Bank C 3.8315% 15 3.8315% 5 Bank D 3.8415% 12 0 Ad Hoc Auction Method Tap Method
Bond Issuances in Primary Market Other Bonds via Public Issuance Registration - The bond issuer engages a team of intermediaries to prepare the registration statement and all other required documents for the registration of the bonds to the relevant regulatory entity, generally the securities commission. Sale/Marketing to Public - Simultaneously, the bond issuer also engages a syndicate of underwriters for the marketing of the bonds, and in advising the issuer on the terms of the bond offer including the pricing and the timing Listing - Upon approval of the registration and the end of the offer period, the bonds are to be listed in a platform exchange.
Bond Trading in Secondary Market Exchange Traded vs OTC-Traded Centralized Market An exchange provides a centralized market where all trades are done; OTC market is decentralized where trades are conducted among market participants Regulatory Monitoring/Counterparty Risk An exchange is considered more regulated and lessens counterparty risk Price Transparency Quotes and trades done via an exchange can be accessed by market participants
Bond Trading in Secondary Market Market Participants Front Office tasked with executing bond trades; includes dealers and brokers Back Office processing of trades including settlement, clearing of funds, and accounting Custodian tasked with safekeeping of bonds Transfer Agent act as record keeper of the bond investors of a company
Bond Trading in Secondary Market EXCHANGE PLATFORMS FOR BOND TRADING People s Republic of China Hong Kong, China Indonesia Republic of Korea Malaysia Philippines Singapore Thailand Viet Nam National Association of Financial Market Institutional Investors (NAFMII) HKMA, Central Money Market Unit Indonesia Stock Exchange (IDX) Indonesian Central Counterparty Indonesian Central Securities Depository Korea Financial Investment Association (KOFIA) Korea Exchange (KRX) Bursa Malaysia Financial Market Association of Malaysia PDS Group (Philippine Dealing and Exchange) Singapore Exchange (SGX) Thai Bond Market Association (ThaiBMA) Vietnam Bond Market Association (VBMA)
Source: ABMF Volume 2 Part 3 : Bond Market Infrastructure Diagrams, Domestic Bond Transaction Flows, and Cross-border Bond Transaction Flows